I'm pretty sure the old accounting rules allowed for judgement in determining temporary vs permanant decreases in value.

I don't think that accounting pronouncements and rules would make any difference on the above example. The loan contract is the problem, allowing for the loan to be called based on certain contingencies.

The solution is to not enter into a contract with the underlying contingency. I don't think standard mortgages have this (it is a different issue if you stop making payments, but I bet highly leveraged financial instruments do!

It appears that lower cost of market is a more conservative method of valuing assets at the outset for which their is no market or they are highly illiquid.

Is there any other method? I think the reason many people are starting to sound the horn on mark-to-market is because they are ignorant (at least, I will admit as much).

Let's take the following scenario recently explained to me:
Imagine a street where the houses are all worth $1 million, and each has a $500,000 mortgage. But a clause specifies that if a house's value declines to less than double the loan, the mortgage will go into default. Now, suppose one homeowner is forced to sell, and has to accept a lowball offer of $600,000. Using mark-to-market rules, the lender would have to judge all the other homeowners technically in default, forcing them to raise additional cash or perhaps sell their homes. That's what has been happening in the financial world.

What is the appropriate way to deal with this situation? Thanks for your earlier posts. Most helpful.

Caveat emptor... but it is hard when it we create millions of casual investors through 401(k) plans, and deal with political leaders who alternate between blaming the market for all ills and praising it for all benefits...

Is it truly a roulette wheel?

"it leaves casual investors with out an good understanding of the upside of company assets"

but i think this raises an important point, not intended. The reality is NO accounting system will save a CASUAL investor from themselves. too many people (pros and amateurs alike) apply non-rigorous/non-existent analytical processes to problems such as investing - and you can't save them from themselves no matter what you do really.

When you take out a $3.0M loan securitized by a building on the books for $100K or $1.5M you still receive a Cash! Presumably, the use of that cash is going to create revenue or to purchase a seperate asset that will increase the overall value. The above example assumes the cash has come in and was squandered...

Lower of cost of market does have problems - it leaves casual investors with out an good understanding of the upside of company assets. But we can hardly argue that they have been better served by mark to market...

How about keeping the books at lower of cost or market, and disclosing the Market values in the footnotes?

As I noted in my post, mark-to-market accounting has been the standard since 1991. I fail to see how Sarbanes-Oxley (passed in 2002) has anything to do with it, other than by holding top executives more accountable for any false accounting statements. But I do see that connection made a lot these days, so I'll do some checking on it.

These are all simplistic examples..

Issue 1 - Inability to compare time differentiated assets and liabilities
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Acme Corp buys is corporate building for cash in 1980 for $100k. In 2009 it has a fantastic idea and takes a secured loan against the building for $3mil to fund the idea.

Assets: $100k
Liabilities: $3million

Do we know if the building is worth $3mil? No. We do know it is almost certainly worth more than $100k tho.

Imagine thousands of these piled up in a real companies books.

Issue 2 - Inability to compare similar companies due to time differentiated asset recording
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CopyCat Corp likes acmes HQ so much, in 1995 it buys the identical building across the street for $1.5mil. It also has the same idea and takes out the same loan..

Acme:
Assets: $100k, Liabilities: $3mil

CopyCat:
Assets: $1.5mil, Liabilities: $3mil

While neither of these companies looks like a great balance sheet, acme looks like a stinker comaratively, even tho it is in fact exactly the same.

And again, the idea is to remember there will be hundres, thousands, millions of these assets and liabilities on the books across any company of any medium to large size. Many of the details won't be broken down to any useful detail in the books for investors to look at..

This is not to say that the issue of bonuses rewarding short term behaviours of CEOs and traders. It is a valid point. But conservative historic cost accounting seems to create some problems as well. In fact, it may create the incenvtive to do deals just for doing them to realize some gains (and not have to worry about unrealized losses).

But it is okay for the SEC to decree the use of certain accounting standards? Are you not aware that the SEC enforced the MTM rule because it initially thought it was legally required to under Sarbanes-Oxley, a law passed by Congress?

If you really believed your statement, then why are you not outraged about "the last time the people on Capitol Hill seriously messed with accounting standards"--the Sarbanes-Oxley Act, which is all about meddling into accounting issues?

Or do you only believe your own statement when it preserves other forms of government interference into the free market?

Hypocrisy much?